Harris Corp. to Buy Exelis for $4.56 Billion

Deal Could Trigger Further Consolidation Among Mid-Size Defense Contractors

The combination would give Harris Corp., a maker of military radios and other equipment, an enhanced role in air-traffic safety modernization efforts being pursued by the FAA.
Photo:
Harris Corporation

Harris Corp.
’s deal to buy a smaller defense-industry rival, the largest defense deal in almost 20 years, has the potential to spur more consolidation as the Pentagon budget stabilizes.

The Melbourne, Fla., maker of military radios and air-traffic control equipment agreed to buy
Exelis Inc.
for about $4.56 billion, creating a top 10 Pentagon supplier by sales and uniting two midtier companies viewed as potential takeover targets.

The proposed takeover would be the largest in the defense sector since the takeover boom of the 1990s that created such giants as
Lockheed Martin Corp.
Contractors have avoided big acquisitions because of uncertainty over the Pentagon budget, opting to return cash to holders or expand into non-miliary areas.

The enlarged Harris would have pro forma annual sales of around $8.2 billion and rely on the Pentagon for around half its revenue, a bigger share than at present. “Two or three years ago, buying into the [defense industry] was like catching a falling knife,” Harris Chief Executive
Bill Brown
said in an interview. “Now I think it’s the opposite.”

This week, the Obama administration unveiled a budget that signals a modest rise in military spending following five years of cuts in buying weapons and research, though the proposal faces tough scrutiny in Congress.

An uncertain military budget outlook that kept defense companies from pursuing large deals led them to focus on internal cost-cutting and returning billions of dollars in cash to shareholders, helping their stocks outperform the broader market over the past two years.

The Pentagon has indicated it doesn’t want mergers among the five prime defense contractors, but investment bankers said large and medium-size companies would likely view the Harris deal as a potential trigger for a return to deal-making.

Mr. Brown said talks with Exelis started in October after that company spun off its mission systems business, a move widely viewed as prepping it for sale. He said he expects the deal to be welcomed by the Pentagon without the need for any disposals because the department wanted more stability and competition among suppliers.

The deal “represents the re-emergence of a stronger midtier defense sector and may entail more competition for primes in some defense segments,” said analyst
Byron Callan
at Capital Alpha Partners LLC.

Harris also spends more than most peers on internal research and development—5.4% of sales in the latest quarter—and the Pentagon has been pushing contractors to boost investment and take on additional risk as part of broader acquisition reforms.

Exelis, which was spun out of
ITT Corp.
in 2011, had sales of $3.2 billion last year after the mission-systems spinoff. The company specializes in parts for commercial and military aircraft as well as sensors and radar technology.

Mr. Brown said there were opportunities to leverage Exelis’s portfolio to sell more data from the enlarged company’s sensor business to military and commercial customers.

Analysts said they didn’t expect a rival bid to emerge as defense companies have shied away from contested deals.

The combined business would have an enhanced role in air-traffic safety modernization efforts being pursued by the Federal Aviation Administration. Exelis has led the installation of new ground stations designed to provide air-traffic controllers with more accurate data about position of aircraft. Harris, among other things, for many years has been in charge of a large part of the FAA’s communication networks between facilities.

Exelis’s board approved the deal, which is expected to close in June subject to regulator and shareholder approvals. Harris forecast pretax cost synergies of between $100 million and $120 million. Savings would come from consolidating the companies’ headquarters and eliminating other costs from operations.

Harris shares rose 9.6% to $76.18 and Exelis’s stock jumped 36% to $24.13, both in 4 p.m. New York Stock Exchange trading on Friday.

Harris offered about $16.63 in cash and 0.1025 of its own shares for each Exelis share, a 38% premium over Thursday’s close and at a valuation that analysts viewed as fair.

—Michael Calia contributed to this article.

Corrections & Amplifications

Mr. Brown of Harris said talks with Exelis started in October after that company spun off its mission systems business. An earlier version of this article said talks began in September. Also, the photo shows a Harris Corp. Falcon III AN/PRC-117G wideband manpack radio. An earlier caption incorrectly described it as the Falcon III AN/PRC-152A.